1. Essentials of Heterodox and Post-Keynesian Economics Marc Lavoie University of Ottawa

2. The global financial crisis has had an impact on… Students of economics Some reporters Trade unions Central bankers The IMF

3. But little impact on … The European Commission Most academic economists and their economics departments

4. Where has economics been going? “Indeed, the typical graduate macroeconomics and monetary economics training received at Anglo-American universities during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding.” –Willem Buiter, 2009 (former member of the Monetary Policy Committee of the Bank of England)

5. Where could it go? Stop the growing hegemony of neoclassical economics in economics departments. Stop repressing dissent. Change the curriculum. Less emphasis on techniques, more emphasis on history and institutions Introduce more competition in the field of economic ideas: bring in heterodox schools of thought

6. Outline 1. Heterodox economics versus orthodox economics 2. Post-Keynesian economics 3. Who’s afraid of neoclassical economics?

7. PART I Heterodox economics versus orthodox economics

8. Heterodox vs Orthodox economics HETERODOX ECONOMICS NON-ORTHODOX ECONOMICS POST-CLASSICAL ECONOMICS RADICAL POLITICAL ECONOMY REAL-WORLD ECONOMICS NEW PARADIGM ECONOMICS ORTHODOX ECONOMICS DOMINANT PARADIGM NEOCLASSICAL ECONOMICS THE MAINSTREAM MARGINALISM OLD PARADIGM ECONOMICS

9. Heterodox schools in economics Post-Keynesians Sraffians (Neo-Ricardians) Old Institutionalists Marxists, Radicals Development Structuralists (Latin-American school, Furtado, Prebisch) French Regulation School, Social Structure of Accumulation (SSA) Neo-Schumpeterians Circuitists Social economics and Humanistic economics Anti-Utilitarism (MAUSS) Economists of « conventions » Feminist economics Green economics (Ecological Economics) Old behavioural economics And no doubt many others (Ghandi economics, Henry George, Gesell, Polanyi, system dynamics, agent-based, Neo-Austrians(?)...

10. Macro- economics Heterodox authors Marxists Radicals French Regulation School Cambridge Keynesians Post- Keynesians Neoclassical school Old Keynesians New Keynesians Monetarists New Classicals KEYNES

11. Dissenters in economics HeterodoxyOrthodoxy Dissenters Mainstream

12. Examples of orthodox dissenters Milton Friedman Amartya Sen George Akerlof Paul Krugman Joseph Stiglitz Oliver Williamson Ronald Coase William Vickrey ? Herbert Simon ? Keynes ?

13. What do all these heterodox schools have in common? Differences between schools of thought and their relative ranking have a lot to do with the sociology of the profession. Some of the discrepancies are due to specialization in certain fields (cf. T. Lawson). Still, in my opinion there are broad features that characterize heterodox and orthodox schools. These are called the presuppositions of research programmes by philosophers of science: they are things that cannot be questioned

14. Paradigm PresuppositionHeterodox schoolsOrthodox schools Epistemology/OntologyRealismInstrumentalism MethodHolism, organicismIndividualism, atomicism RationalityReasonable rationalityHyper rationality Optimizing agent Economic coreProduction, growth, income effects Exchange, scarcity, substitution effect Political coreRegulated, tamed, markets Unfettered market optimism Presuppositions of the heterodox programme vs those of the mainstream

15. Instrumentalism vs realism Friedman’s as if doctrine « Good models have to necessarily be artificial, abstract, patently unreal » (Lucas, 1981) « Of course, that model does not not represent reality and that is not its purpose » (Bliss, 1975) « It is better to be precisely wrong rather than roughly right » Ex.: The use of the Gaussian copula function to price CDO (collaterized debt obligations) was based on an index of CDS (credit default swaps) market prices instead of looking at true default rates.

16. Rationality “ Orthodox macroeconomists came to conflate being rational with thinking like an orthodox economist. What this implied was that agents knew the one and only true model of the economy (which conveniently was stipulated as identical with neoclassical microeconomics)”. (Philip Mirowski, 2011) ‘A systematic deviation from an “insane” standard should not automatically be called a judgmental error’ (Gerd Gigerenzer, 2008)

17. Scarcity versus production Economics is the study of scarcity (Robbins, 1932) « Neoclassical economics is the study of an upward- sloping supply curve with a downward-sloping demand curve » Vs « Economics is the study of the process by which society brings its available resources into production, and the distribution of that production among its members. » (John Weeks, 2012)

18. Distrust in unfettered markets « On the one side are those who believe that the existing economic system is, in the long run, a self-adjusting system, though with creaks and groans and jerks and interrupted by time lags, outside interference and mistakes …. On the other side of the gulf are those that reject the idea that the existing economic system is, in any significant sense, self-adjusting » –Keynes, CW, xiii, p. 487 (1934)

19. Holism: Some crisis-related macro paradoxes Paradox of thrift (Keynes 1936)Higher saving rates lead to reduced output, Paradox of costs (Kalecki 1969, Rowthorn 1981) Higher real wages lead to higher profit rates Paradox of public deficits (Kalecki 1971) Government deficits raise private profits Paradox of tranquility (Minsky 1975)Stability is destabilizing Paradox of debt (I. Fisher 1933, Steindl 1952) Efforts to de-leverage might lead to higher leverage ratios Paradox of liquidity (Dow 1987, Nesvetailova 2007) Efforts to become more liquid transform liquid assets into illiquid ones Paradox of risk (Wojnilower 1980)The possibility of individual risk cover leads to more risk overall Paradox of profit-led demand (Blecker 1989) Lower wages lead to slower growth despite all countries being profit-led

20. Edward Fullbrook(2013): new paradigm Start from real data not apriorism Real-world rationality Holism No market clearing Disequilibria Pluralism Math-formalism upside-down Radical uncertainty Economy is a subset of biosphere Facts and values are inseparable

21. Summing up this part…. Heterodox economics is distinct from orthodox economics. The various heterodox schools of thought have a lot in common, especially on the methodology side. Different schools of thought often focus on different fields, so that their similarities are not always obvious. But just as there are battles between New Classical and New Keynesian economics, there are disagreements between various heterodox schools.

22. Part II Post-Keynesian economics

23. Phases in the creation of PKE 1930s-1950s: The Beginnings: –Keynes 1936 Robinson 1956 1960s-early 1970s: The Capital controversies, the response to monetarism –Sraffa, Pasinetti, Garegnani – Kaldor, Davidson Mid 1970s-1980s: The Romantic Age –Kregel-Eichner, syntheses, institutionalization 1990s: The Age of Uncertainty –Methodology 2000s: The Age of Policy

24. PKE adopt the five general heterodox presuppositions

25. Specific post-Keynesian presuppostions The relevance of the principle of effective demand (demand-led economies) –Both in the short and the long run –The supply adjusts to demand (inversed Say’s law), but see Kalecki and Robinson on capacity constraints –The autonomy of investment from inter-temporal decisions of households (investment causes saving) The importance and irreversibility of time –Historical time –Dynamics, the traverse –The long run is a consequence of a series of short runs, there is no independent long run trend –Path dependence, multiple equilibria –Tracking financial stocks through time

26. Auxiliary post-Keynesian features Fundamental or radical uncertainty A monetary production economy Alternative microeconomics (little reliance on substitution effects) Diversity of methods and theories Institutions make a difference (Monetary and fiscal policies do have an impact on real quantities)

27. q q fc q th AVC = DUC = mc TUC mc AVC The shape of cost curves

28. The various PK strands: 5-way typology Fundamentalist or Financial Keynesians: –Money, finance, liquidity preference, uncertainty, methodology –Davidson, Minsky, Kregel, Chick, Dow, Fontana Kaleckians: –Pricing, growth, cycles, employment, income distribution –Sawyer, Bhaduri, Dutt, Blecker, Fazzari Sraffians: –Relative prices, technical choice, input-output models, capital theory –Garegnani, Kurz, Pasinetti, Steedman Institutionalists: –Institutions (firms, banks), pricing, behavioural economics – Fred Lee, Peter Earl, Galbraith 2x, MMT (Wray) Kaldorians: –Growth, money, international trade, productivity growth –Godley, Thirlwall, McCombie, Palley –Some authors go across the strands: Arestis, Nell….

29. Part III Who’s afraid of neoclassical economics or why do neoclassical theories always seem to be supported by empirical evidence?

30. Theoretical constructs rejected by PK economists NAIRU or the natural rate of unemployment The loanable funds theory and the natural rate of interest Crowding-out effects (except for possible psychological effects) Say’s law Inflation is a monetary phenomenon Aggregate employment determined in the labour market Higher saving leads to higher investment The government debt constraint is similar to that of households The efficient market hypothesis, in its various incarnations That unemployment is only due to sticky prices Bank reserves cause bank loans and deposits Unit cost curves have a U-shape

31. Another theoretical construct rejected by PK economists The well-behaved neoclassical production function For instance the Cobb-Douglas production function This was at the heart of the Cambridge capital controversies of the 1960s and 1970s It was shown that standard results of neoclassical theory obtained with such aggregate production functions did not hold in a model with two or more sectors (say, two sectors producing investment and consumption goods respectively)

32. L/K w/p LDLD (a)(b) (c) LSLS LDLD LDLD Cambridge UK vs Cambridge Massachusetts

33. The response of neoclassical economists « Placing reliance upon neoclassical economic theory is a matter of faith’ (Ferguson, 1969) Regressions based on the Cobb-Douglas seem to work, when properly specified. It works, therefore it exists (Empirism)

34. The counter of post-Keynesians The coefficents of the regressions are supposed to yield the output elasticies of labour and capital, which depend on technology. In reality, because macro data must be deflated, what is truly being computed by these regressions are the wage and profit shares in national income. This has been demonstrated by John McCombie (2001) (see the recent book of Jesus Felipe and John McCombie (Not Even Wrong, 2013)

35. This puts in jeopardy all of neoclassical economics because… « The neoclassical production function is the cornerstone of neoclassical theory and is used in virtually all applied analyses » (Prescott 1998) NAIRU measures, labour demand functions and wage elasticities; investment theory; measures of multifactor productivity or total factor productivity growth; estimates of endogenous growth; theories of economic development; theories of income distribution; estimates of cost functions; measures of potential output; theories of real business cycles; estimates of the impact of changes in the minimum wage, social programs, or in tax rates.

36. Further issue: publication bias Data fishing, data mining, data massaging Now famous example: the Reinhart and Rogoff (2010) AER study on the negative impact of public debt ratios above 90% Herndon, Ash and Pollin (2014) found there were coding mistakes, omitted entries, unconventional weighting. « Reviewers and editors [of academic journals] may be predisposed to accept papers consistent with the conventional view » (Tom Stanley, 2005)

37. Meta-regression analysis: regression on regression results

38. Meta-regression analysis … Shows that more than half of the fields of research suffer from severe publication bias. Falsifies the claim that larger government deficits lead to reduced household spending (Ricardo equivalence theorem) Falsifies the claim that there exists a natural rate of unemployment towards which the economy converges. Also falsifies the claim that expected inflation leads to a one-on-one increase in the rate of inflation. Thus, the NAIRU, which is at the heart of current monetary policy, is falsified.

39. The role of post-Keynesian economists (and young economists in general) The crisis has clearly demonstrated, if such a demonstration was needed, that there is something wrong with mainstream economics (Financial Times: “The credit crunch has destroyed faith in the free market ideology”). In view of these failures, it is our social duty to keep developing an alternative view of the economic system. It is our duty to sustain and clarify the heterodox traditions that question the efficiency of unfettered markets.